This bubble can be bigger than the one of 2008

Aug 9, 2010

In this issue:
» Next crisis can come before the financial system is prepared
» There is no asset bubble in India, says CLSA's Wood
» SEBI chief's honesty irks the wrongdoers
» 75% of company boards in India do not discuss succession
» ...and more!!

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In being the world's biggest manager of bond funds, Bill Gross of Pimco knows a thing or two about the mood at the US central bank. And what Gross believes is that the Federal Reserve is unlikely to raise interest rates for the next 2-3 years.

The Fed has in fact maintained a range of 0-0.25% for its benchmark rate for short term loans since December 2008. It has done this to encourage the recovery in the world's biggest economy. Now with Gross expecting the Fed to maintain the dollars cheap, we see this as laying the foundation of a financial bubble. A bubble that could perhaps be bigger than the one we saw prior to 2008.

After all, isn't the plan of solving the crisis (caused by cheap dollars) using cheap dollars, a dangerous proposition? This will lead to excessive risk taking by speculators to speculate in stocks. What is more, things could once again go overboard to cause a bubble.

The risks especially lie in emerging markets that have seen a huge inflow of low cost global liquidity over the past 18 months. This has led to sharp surge in stock prices in these countries. We have seen this in India as well, where foreign investors have infused around US$ 11 bn so far in 2010 alone. Stock prices here have risen by anywhere between 1 and 10 times since March of last year.

With more cheap dollars available, and for a longer time, stock prices in emerging markets like India can rise even further. But the house could well come crashing down the day the supply stops!

 Chart of the day
Today's chart of the day speaks the sorry tale of Indian retail investors, who have borne the brunt of market crashes in the past. It shows the share of household financial assets invested in shares and debentures of companies. Interestingly, in all the three occasions when this share has peaked since 1990, the Indian markets have crashed just thereafter. Call it a case of bad market timing!

Data Source: SEBI

Why do you think the financial crisis of 2008 was worse than anything that the world has seen in recent years? Well, it involved the banking system. And crises that emanate from the banking system have quite far reaching consequences than the ones that emanate from any other source. Thus, in order to avoid any such catastrophes in the future, it is necessary that the banking system is strengthened further.

Unfortunately, thinks are moving at a very slow pace on this front in the US. As per Bloomberg, there are chances that by the time the next crash comes in say around 2015, banking reforms could still not be in place. No doubt the US President has already signed the landmark financial regulation bill. But its implementation leaves a lot to be desired.

A set of new guidelines for leverage, capital and liquidity is coming under attack by financial companies and some governments. These agencies are arguing that the steps might curb lending and hamper economic recovery. This is thus leading to relaxation of rules and extension of timelines. Not a very good sign indeed as this would encourage continued risky behaviour and may once again cause enormous damage to the banking system.

It is a question many foreign investors are asking today. Is it still a good time to invest in India? Or are we already in an asset bubble. If Christopher Wood, managing director of CLSA, is to be believed, there is no asset bubble in India. The reason being, the India growth story inherently can deploy the additional money coming in. The massive need of infrastructure means that the money can be used productively for the next 10 years. Compare that to Hong Kong or Singapore where additional money cannot be used to build more infrastructure.

Wood also believes that this infrastructure led growth is the key to higher valuations. If infrastructure building slows down, Indian stock markets would become unattractive.

Anyways, Indian markets had a good outing today. The BSE-Sensex was trading with gains of around 105 points (0.6%) at the time of writing this. The overall gains were led by buying in stocks from the realty and metal sectors. IT and energy stocks were the worst performers.

Among other key Asian markets, while China and Hong Kong closed up by 0.5% and 0.3% respectively, weakness was seen in Japan (down 0.7%) and Singapore (down 0.4%).

The fact that SEBI chief Mr. C.B. Bhave has been vocal about the inability of 3,000 odd mutual fund schemes to serve investor needs has not earned him any brownie points. In fact his frank opinions have off late made him quite unpopular amongst those of his ilk as well as fund managers.

"Investors are intelligent. If we have not been able to convince them, even with thousands of mutual fund schemes, there's some problem with the products. We are not getting to the heart of the matter." With such candid words, Mr. Bhave recently cited the key reason for the Indian mutual fund industry losing 4 lac investor accounts in the past few months. The IRDA-SEBI battle over ULIPs going in favour of the former has also made him vulnerable to the sentiment of the market players. However, for once a clear thinking regulator seems to be doing a good job of rooting out the bad weeds. We only hope that others take some learning from him.

The board seats of industry chieftains, Ratan Tata and Narayana Murthy are about to become vacant. It is now time for the leadership baton to be passed on to the next rung of leaders. But, is corporate India ready for the challenge?

As per a survey by Bain & Company, over 75% of company boards in India do not discuss CEO succession planning at all! Contrast this with the US, where more than 60% of the top companies discuss this topic every year. And 80% of these companies already have an emergency succession plan in place.

Considering the messy succession issues, companies like Reliance, Bajaj, and Birla faced in the past, it is welcome news to see panels and committees being put in place at the Tata Group and Infosys to resolve this issue. We hope others will take a leaf or two out of this.

Bad news for US has been pouring in every week with bad unemployment data, low consumer spending and so on. But despite it all, the Obama administration has been confident that the US is on its path to recovery. At such times, it came as a bombshell when investment guru Robert Prechter predicted that the Dow Jones Index will plunge to 1,000 levels.

Well, that's a drop of almost 90% from the current levels. That's why all market analysts and economists dismissed this as an irrational claim. But investment icon Marc Faber agrees that Dow could indeed plunge to 1,000 levels. His rationale is that when any mania ends, stock markets go back to the levels at which they were when the mania first started. To him, the mania started way back in 1970s when the Dow was at 1,000 levels!

 Weekend investing mantra
"Stock speculation is largely a matter of A trying to decide what B, C and D are likely to think-with B, C and D trying to do the same." - Benjamin Graham

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5 Responses to "This bubble can be bigger than the one of 2008"

Indian man

Aug 22, 2010

very good article. Take a look at last 15 days fund flow- no top FIIs are investing, no top Hedge funds are investing, no DII are investing - total 22% funds have come in from these entities. Rest 78% from unknown FIIs. Is someone watching this - where is SEBI?

i think smallinvestors are taken for a ride here


Sivaraman V

Aug 10, 2010

Stock Speculation is a game of Guessing the Guessers


Kaushal Mahajan

Aug 10, 2010

Agree with Madhur (though i do not think that its a funny chart!) - good point.
The only conclusion that i can safely draw from this chart is cyclicality - that when market rises, % share of households' capital market assets go up and then they fall (since the market has fallen). Which is the same as saying that markets are cyclical. i.e. a spike is followed by a crash.



Aug 9, 2010

My view is exactly that of Mr Madhur.


Madhur Kotharay

Aug 9, 2010

What a funny chart about household investments into shares and debentures? Looks like it was prepared by someone who ran out of ideas for the graph of the day.

When the share market rises and rises, the value of shares held by households rises disproportionately to their other assets. So obviously, in bull markets, the percentage of equities in household holdings increases. As the markets fall, this percentage comes down because shares drop in value.

Also, in such times, Gold rises in value and equity percentages drop even more. So even if the investor does NOTHING in a business cycle (forget 'trying to time the market'), the graph would look exactly like this. Thus, this is less of bad market timing and more of mathematical eventuality. Don't draw conclusions on flimsy grounds!

Now, given that 75% of Indian investors are clueless about the markets, do you really expect them to do very tight asset reallocation, in which case this percentage would look flat across the business cycle?

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